California-based Chevron’s (NYSE:CVX) second quarter earnings were down sharply on refinery downtime, soft commodity prices and lower upstream production. Reported earnings per share (EPS) declined 24% to $2.77. However, the company’s production outlook remains positive as the major growth projects are on track. 
Chevron is the second largest energy company in the U.S. after Exxon Mobil (NYSE:XOM). The company manages its investments in subsidiaries and affiliates, and provides administrative, financial, management and technological support to its U.S. and international subsidiaries engaged in fully integrated petroleum, chemicals and mining operations as well as power generation and energy services.
Refinery downtime and lower margins realized on the sale of refined products were a drag on Chevron’s downstream earnings, which were down ~60% y-o-y. The volume of crude oil processed by the company’s U.S. refineries declined by 12% as the crude unit at its Richmond based refinery remained shut due to the explosion that took place last August. Planned turnaround activity at the Hawaii refinery further reduced processing capacity. Maintenance activities also drove refinery expenses higher putting pressure on margins.
We expect Chevron’s refinery output to pick up during the second half of the year as the Richmond refinery has been successfully restarted. Moreover, GS Caltex’s Yeosu refinery in South Korea also began commercial operation of the heavy crude upgrading unit. Chevron operates in South Korea as a 50% shareholder in GS Caltex Corp., the country’s second-largest energy company.
Crude Oil Prices
Lower international oil prices negatively impacted Chevron’s operating results. While average WTI prices were marginally higher year-on-year during the second quarter, average Brent prices declined more than 5% over the same period. Since the company derives ~75% its net liquids production from international markets, lower Brent prices weighed on its earnings.
We forecast crude oil prices to increase in the long run primarily due to incremental demand from emerging economies such as China and India, where growing populations and rising income levels make a solid case for higher energy requirements.
However, we expect international crude prices to increase at a very conservative 2% CAGR in contrast to almost 15% CAGR seen over the last decade. This is because we believe the rising oil production in North America, mostly coming form unconventional sources such as shale oil in the U.S. and oil sands in Canada, will increase the supply of oil from non-OPEC countries significantly, thereby reducing pricing power long held by OPEC countries. The short-term volatility in crude oil prices will remain; however, long-term fundamentals appear to have swung positively for a much smoother demand-supply equation than seen in the past. According to an IEA report, U.S. production is likely to grow by almost 3.9 million barrels of oil per day by 2018, which will change it from the largest importer to a net exporter of oil. 
Chevron’s total net oil-equivalent production declined ~2% y-o-y to 2,582 thousand barrels per day (MD/day), as natural field declines more than offset the incremental production from Angola LNG and project ramp-up in the U.S. Chevron reported the first LNG shipment from the Angola LNG project during the second quarter and expects to ramp up production during the second half of the year. The project is expected to boost the company’s net oil equivalent production by ~60 MB/day at peak rates. (See: Chevron’s Angola LNG Project Will Help Slake International Gas Demand)
With the key projects on track, we expect Chevron to meet its aggressive production growth target by 2017. The company reported that the Gorgon Project is ~67% complete and is on track for late 2014 start up. The project includes the construction of a 15.6 million ton per annum (MTPA) LNG plant on Barrow Island and a domestic gas plant with the capacity to supply 300 Tera-Joules of gas per day to Western Australia. The LNG facility will ensure easy transportation of natural gas to the fast growing Asian economies. The Gorgon project forms the centerpiece of Chevron’s production volume ramp-up plan. It is expected to add over 200 MB/day to the company’s net production volume. Apart from Gorgon, the Wheatstone project in Australia, which is expected to start operations by 2016, will also boost the company’s production volume.
We have updated our price estimate for Chevron to $138 based on the second quarter earnings results.
- Chevron Reports Second Quarter Net Income of $5.4 Billion, investor.chevron.com
- US shale oil supply shock shifts global power balance, bbc.co.uk
Disclosure: No positions